Integra Lifesciences Holdings Corp (IART) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the Integra LifeSciences Third Quarter 2010 Conference Call. As a reminder, today's call is being recorded. At this time for opening remarks, I would like to turn the conference over to Ms. Angela Steinway, Head of Investor Relations. Please go ahead.

Good morning, and thank you for joining us for the Integra LifeSciences Third Quarter 2010 Earnings Release Conference Call. Joining me today are Stuart Essig, Chief Executive Officer; Jack Henneman, Chief Financial Officer; and Gerry Carlozzi, Chief Operating Officer.

Earlier this morning, we issued a press release announcing our third quarter financial results. This release is available on our website in the Press Release section under Investor Relations. During this call, we will review these financial results and update our forward-looking guidance for 2010.

At the conclusion of our prepared remarks, we will take questions from the telephonic audience. So we will try to keep the call to an hour, we would like to continue our tradition of answering all of your questions.

As a courtesy to all so that we may accommodate a large number of requests, please limit yourself to one question and one follow-up during the Q&A period. If you do have additional questions, please rejoin the queue.

This presentation is open to the general public and can be heard through telephone access or a live webcast. A replay of the conference call will be accessible starting about one hour after the conclusion of the life event. Access to the telephonic replay is available through November 11, 2010 by dialing 719-457-0820, access code 4380846. Additionally, a webcast replay will be archived on the Investor Relations page of our website.

Today's call is a proprietary presentation of Integra LifeSciences Holdings Corporation and is being recorded by Integra. No recording reproduction, transcript or distribution of today's presentation is permitted without Integra's consent. Because the content of this call is time-sensitive, the information provided is accurate only as of the date of this live broadcast, October 28, 2010.

Certain statements made during this call are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Among others, the statements concerning management's expectations of future financial results, new product launches, regulatory approval, and market acceptance of these new products, future product development programs, and potential business acquisitions are forward-looking.

Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from predicted results. These forward-looking statements are made only as of the date hereof and the Company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.

For a discussion of such risks and uncertainties, please refer to the risk factors included in Item 1-A of Integra's annual report on Form 10-K for the year ended December 31, 2009 and information contained in our subsequent filings with the Securities and Exchange Commission.

Certain non-GAAP financial measures are disclosed in this presentation. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures is provided in the press release we issued this morning.

Additionally, in this press release and in the current report on Form 8-K that we filed this morning, we provide explanation for why management believes that presentation of these non-GAAP financial measures provides useful information to investors regarding Integra's financial condition and results of operations, and the reasons for which Integra's management uses the non-GAAP financial measures.

I will now turn the call over to Stuart.

Thank you, Angela. We performed well in the third quarter. Total revenue increased to a record $187 million, up 8% as reported and 9% on a constant currency basis. Our third quarter results reflect the consistent contribution of internal growth to our financial performance. We are excited about our opportunities for the rest of 2010 and 2011.

Orthopedics, which includes products sold to foot, hand, spine and orthopedic surgeons, represented approximately 39% of Integra's overall revenue during the third quarter, an increase of 14% to $73 million over the prior year period. Extremity reconstruction, which is the largest component of our Orthopedics category, posted double-digit growth. Strength in our US business offset some weakness in Europe.

Sales were particularly strong in skin, midfoot, and hindfoot product lines. Spine and orthobiologic sales were essentially flat. Improvements in US spinal hardware sales were offset by decreases in European orthobiologics. Our efforts to better support our distributors and assign managerial and technical resources in the US are beginning to pay off. Private label revenue increased significantly, with all major product lines up from the prior year.

Neurosurgery revenues grew 4% to $70 million, representing approximately 37% of Integra's overall revenue. European sales were down over the prior year period. Sales of capital products in the US including ultrasonic tissue ablation, cranial stabilization, and stereotaxy product lines again drove the growth in this category.

Instruments accounted for 24% of our overall revenue in the third quarter. Instrument revenue of $44 million increased 7% over last year, the strongest performance by this category in just over two years.

In the acute care setting, loosening capital budgets and some new hospital and surgery center construction contributed to a strong performance. Demand for instruments is also steadily improving in our office-based sales channel.

Consolidated international sales accounted for 22% of revenue in the third quarter. International revenue increased 3% as reported and 6% on a constant currency basis. Austerity measures hurt European results, particularly capital sales in Neurosurgery and Instruments. Regulatory changes requiring the re-registration of certain products temporarily affected our orthobiologics results in Europe. Weakness in Europe was, however, offset by a significant increase in sales to Asia-Pacific.

Integra had a great quarter. Better sales execution; the diversity of our business; and improvements in the US economy have contributed to Integra's consistent revenue performance year-to-date. We recorded expenses in line with our plan and revenues [beat], so we were able to translate more leverage to the bottom line.

In addition, I'm pleased with our financing activity for the quarter. We completed a very favorable bank financing during the third quarter, doubling the size of our credit facility, extending its maturity to 2015 and expanding our lending group from 15 banks to 22. We also repurchased over 850,000 shares in the open market during the quarter.

Before I turn the call over to Gerry to discuss some operational highlights, I want to thank him for his numerous contributions to the growth of Integra over the last seven years. It has been a pleasure to work with him for me personally; his contributions have strengthened our leadership team and increased our ability to execute on key operating objectives.

Gerry has focused the Company on growth opportunities for our existing products and technologies and the integration of newly acquired businesses. Although Gerry is retiring at the end of this year, we are happy that he will be consulting for us for the first half of 2011. He has been a great partner for me in building this Company.

I'm also delighted to be bringing Peter Arduini on-board starting next week. Pete recently left Baxter after five years where he was Corporate Vice President and President of Medication Delivery. There Pete was responsible for a $4.8 billion global division with diversified products ranging from IV solutions and medical devices to pharmaceuticals.

In addition to his accomplishments there, Pete has a broad range of management experience, coming from GE Healthcare, where he managed the CT business as well as global repair and service. We expect a smooth transition and look forward to introducing Pete to the investment community over the coming months.

Now, I'll turn the call over to Gerry to discuss some operational highlights.

Thank you, Stuart. First, extremity reconstruction continues to exhibit strong sales growth. The third quarter represented yet another quarter of double-digit growth. Sales were fueled by several contributing factors. Our skin products and new product introductions including wrist fusion, endoscopic tendon release and new orthobiologics have performed very well.

Additionally, the sales representatives we have been adding are ramping up and becoming more productive. We expect to continue to add 15 to 20 domestic sales reps per year to support this growth.

I will now provide an update on spine. Our US spinal hardware sales increased both sequentially and versus the prior year quarter. This was offset by our European orthobiologics sales, which were down due to regulatory changes in some markets. We view this as a temporary setback.

We are introducing new spine products to our dealer network, adding new dealers and increasingly managing dealers with greater accountability. We are also putting the resources, budgets and personnel in place to optimize surgeon and distributor educational programs. To that end, we recently opened a new medical education center and cadaver lab in Irvine, California and we are expanding our sales, marketing and product development facility in Northeast Ohio.

The new facility in Ohio features expanded capabilities for the production of custom instruments to meet the demands of our customers. As others have noted, the spine hardware market is in transition from high growth and pricing power to relatively lower growth with pricing pressure.

We have experience in competitive markets and are well positioned to exploit change in this environment. We continue to believe that we'll be able to grow faster than the overall market in spine and orthobiologics.

Neurosurgery posted another strong capital quarter (inaudible), stereotaxy and cranial stabilization products, each up nicely over the prior year. New products including the recently launched CRW Precision Arc, our next-generation stereotaxy device, are performing very well. Instruments had a strong quarter, helped by loosening capital budgets and some new hospital construction.

We enjoyed a very strong position through our contracting relationships within each of the six major group purchasing organizations, along with their affiliated integrated delivery network members. These product lines are strong contributors to both operating profit and cash flow.

We are working to streamline and otherwise improve our manufacturing. This effort includes consolidating several of our smaller locations into our larger York, Pennsylvania facility. In the fourth quarter, we expect to complete the closure of our Hawthorne and West Boylston manufacturing and distribution facilities. We are also in the process of consolidating several sites in Akron into one facility. Altogether, these projects will result in a net reduction of approximately 75 positions.

We are also expanding the capacity of a regenerative medicine plant in Plainsboro, New Jersey to support our growth and profit objectives. In addition, our ongoing investment in systems is expanding with our global ERP project gaining momentum. All in, through 2011, we expect to spend approximately $10 million to $12 million per quarter on capital expenditures to improve our manufacturing and ERP systems.

Now, I'll turn the call over to Jack for a review of our financial results.

Thank you, Gerry. On top of the strong revenue performance, we were pleased with the profitability of the Company in the third quarter. In addition to walking through the elements of our P&L, we have a few new items to discuss including the new credit facility and term loan that we completed in August. Stuart will then discuss our outlook for revenue and earnings.

We reported GAAP net income of approximately $16 million, or $0.55 per diluted share, for the third quarter. When adjusted for acquisition-related expenses, other special charges and intangible asset amortization, net income was $22 million, or $0.73 per diluted share. In this quarter, foreign exchange had an unfavorable impact on revenues of approximately $1.5 million versus the same quarter in 2009.

Gross margin on total revenue in the third quarter was 63%, down from the prior year period and the second quarter due to stronger than expected Instrument sales, the expense of continued restructuring, higher than planned manufacturing expenses and higher engineering expenses associated with manufacturing improvement projects. That said, domestic pricing was not a particular culprit in this quarter.

We expect our GAAP gross margin to be approximately 63.5% of sales for 2010. Longer term, we still anticipate improvement in our corporate gross margins of 75 to 100 basis points a year, primarily because of our expectations for revenue growth, operational efficiencies and sales mix.

Research and development expenses in the third quarter increased slightly from the prior year to $12 million, or about 6% of sales. We are targeting spending of approximately 6.5% of total revenue on research and development in 2010.

Selling, general and administrative expenses in the third quarter increased from the prior year to $76 million, or 40.5% of revenue. The increase resulted mainly from additional headcount, higher commissions and bonus accruals. We anticipate that SG&A will approximate 41.5% of sales in 2010. Note that we expect to take a $2.2 million special charge in conjunction with the hiring of our new Chief Operating Officer in the fourth quarter, which will be recorded in SG&A.

In the third quarter, we earned $40 million in adjusted EBITDA and $44 million in adjusted EBITDA excluding stock-based compensation. We reported a $1 million decrease in net interest expense to $4.5 million for the third quarter, resulting primarily from a reduction in debt.

In August, we announced a new credit agreement, which expanded our existing credit facility capacity from $300 million to $600 million. This agreement extended our maturity date from the end of 2011 to August 2015 at very favorable borrowing rates. The new agreement reallocated our existing borrowings under the old credit facility to $150 million five-year term loan and a new revolving line of credit. We expect to be able to use the new revolver to retire our remaining convertible notes when they mature in June 2012.

The P&L impact of this new credit agreement is roughly $1 million of additional interest expense per quarter. The increase results in a little over $5 million of total interest expense per quarter.

The Company recorded $700,000 of other expense in foreign exchange losses on intercompany transactions. Our income tax expense was $6 million, reflecting an effective tax rate of 26% for the quarter. The implied tax rate on our adjusted net income was 29.25%. We expect our tax rate for 2010 will be about 26% on a reported basis and 29% on an adjusted basis.

During the third quarter, we spent $31 million to repurchase over 850,000 shares of common stock on the open market. This transaction reduced our total weighted average of diluted shares outstanding for the quarter by approximately 300,000 shares. We expect share count for Q4 and beyond to remain at approximately 30 million shares, as share repurchases made to date offset the impact of equity grants made, option exercises and the impact of higher share prices on the fully diluted average shares outstanding calculation.

During the quarter, we recorded depreciation of $5.5 million and amortization of intangible assets of $4 million, including $1.5 million in cost of product revenue. The full year of 2010, we expect appreciation of approximately $20 million and amortization of approximately $17 million. Approximately $6 million of the amortization will be included in cost of product revenue.

We expect a quarterly impact of share-based compensation expense in the fourth quarter of 2010, excluding the fully vested equity grant to the new COO, to be approximately $4 million, or $0.08 per diluted share.

In the third quarter, we generated $30 million of cash flow from operations and we spent about $7 million on capital expenditures. Working capital items contributed about $7 million to operating cash flow.

The end of the third quarter also marked the end of the earn-out period related to our acquisitions at Theken Companies in 2008. We have included an estimated $3.4 million payment for the earn-out under our accrued liabilities on our balance sheet, reflecting an expected settlement of the disputed amounts.

At the end of the quarter, we had $83 million of cash, outstanding borrowings of $150 million under our term loan, $70 million under our revolving credit facility, and $165 million of convertible notes outstanding.

We ended the quarter with 51 accounts receivable days outstanding, relatively flat with 50 days at the end of June and down from 54 days a year ago. We had 194 days of inventory at the end of this quarter versus 201 days at the end of the second quarter and 202 days a year ago.

Now, I will hand the call over to Stuart.

Thank you, Jack. We expect to report revenues in the upper half of our original guidance range of $715 million to $735 million for the full year of 2010. Our guidance today assumes that exchange rates will remain where they are now.

Given the strength of the third quarter and our expectation that Orthopedics and Instruments will not grow as quickly in the fourth quarter as in the third, we expect Q4 revenues to increase only modestly over the third quarter and approximately 5% over prior year.

Given the exceptional results in the first three quarter's performance, we are raising our guidance range for the full year adjusted EPS to between $2.72 and $2.80. Fourth quarter adjusted EPS may be the same or slightly lower than the third quarter because we expect to accelerate spending to invest in our extremity recon, spine and orthobiologics, and international businesses. We expect GAAP earnings per diluted share between $1.96 and $2.04.

While we plan to provide 2011 guidance after we report 2010, our early thinking on 2011 is in line with current consensus. Although capital budgets have loosened, the selling environment remains challenging, particularly in our European business. At the moment, we expect 2011 revenue to grow approximately 6% over 2010 reported results.

In summary, we're delighted in our business' consistent, strong execution during the first three quarters of 2010. Longer-term, we believe we have the potential to sustain and improve upon this growth, both on the top and bottom lines. We expect our near-term investments to help realize that potential. With our strong cash flow, we hope to add to our internal growth through acquisitions and strategic alliances.

We look forward to meeting with investors. In November, we will be presenting several investment conferences including the Oppenheimer Healthcare Conference, the Stephens Fall Investment Conference, the Citi Small and Mid Cap Conference, and the Lazard Healthcare Conference.

Additionally, we would like to invite you to attend Integra's annual analyst meeting in New York City, which is scheduled for the afternoon of November 15. Please contact Angela to get the details and to reserve a seat. If you are unable to attend in person, the event will also be webcast and archived, with slides available for download from our website.

Now, we'll be happy to answer all of your questions. As a reminder, in an effort to keep this call to an hour, please do limit yourself to one question and one follow-up. Rejoin the queue if you have more questions. Operator, you may now turn the call over to our participants.

+++ q-and-a

Thank you. (Operator Instructions). Our first question today will come from Matt Miksic with Piper Jaffray.

Hey, Matt.

Sir, your line is open. Please go ahead. Hearing no response, we'll move to our next question with Steven Lichtman with Oppenheimer.

Hi, guys. This is Dave in for Steve. Thanks for taking the questions. I just had a couple of quick questions on spine. First, with the Theken earn-out now complete, what are your plans for expanding distribution? And then secondly, if you could just give a little bit of an outlook on what we can expect from products or product flow in spine.

Sure. Why don't I turn it over to Gerry.

Okay. On the distribution side in the United States, we've continued over the past three quarters to work on improving our distribution channel, expanding to a higher level, more focused distributor network, and we'll continue that effort as we go through the fourth quarter and into 2011.

I think our main objective right now is to do more performance management on the distributor network, get to a higher level of distributor. As we continue to integrate our orthobiologics along with our hardware products into that call point, it's giving us a lot more ability to get more focus of those dealers selling a full product line into the key accounts.

Outside the United States, we have still very little to no distribution on our spine products. And as we go forward into 2011, our objective is to continue to expand our distribution channel, particularly in Europe and the Asian markets. We started making some inroads in terms of the registration and clearing products to create an opportunity to initiate distribution into 2011 in the international markets and we look at that as an outside opportunity from a sales growth standpoint.

On the products side, we introduced a number of new products as we went through the first half of this year, principally the minimally invasive technologies that we had acquired earlier in the year with the launch of our minimally invasive systems in April. And we'll continue to invest in developing and expanding our minimally invasive product lines and try to keep ahead of some of the trends in the market to move more products to a more minimally invasive approach with spine surgery.

We have a pretty robust product portfolio right now in a pipeline where we anticipate adding anywhere from four to five products each half of the year, so about 10 to 12 products as we go on through 2011. And we still have some product launches left for the balance of this year that we're positioning and pretty much from the minimally invasive side to the cervical fusion side to lumbar fusion, so we've been pretty active in the product development cycle and will continue to put the investment into that area.

It's worth pointing out that the NASS meeting that just happened a few weeks ago was actually the first time we presented to the spine community as a consolidated Integra Spine. So the look of the way we presented ourselves, the approach of our people was all Integra Spine as an integrated organization with all of the broad product lines beyond metal in the orthobiologics and soft tissue.

I'd also note that this quarter marked an improvement in the metal side of our business in the US, and the particular culprit in Europe was the delisting of several of our products that needed re-registration in orthobiologics, and we expect that to come back in the fourth quarter and into next year. So it was actually sudden and it didn't just happen to us -- a sudden change in regulation in a number of the key markets for DBM products.

So net-net, in my view, okay performance of our spine and orthobiologics groups, but in the right direction as we go into the fourth quarter and 2011.

All right, thank you.

We will go next to Bill Plovanic with Canaccord.

Great, thanks. Good morning. The first question just is -- Orthopedics was a very nice driver this quarter, and you guys really did a good job on the top line. However, the story has been that as Orthopedics go, so should the gross margin. And we didn't see that materialize, and I was wondering if you could just comment on that.

Sure. A couple of things. First of all, Orthopedics performed quite well. And based on Gerry's comments on the spine and orthobiologics component, you can only take away that extremities and private label did really well. I think that reflects in particular the continued robust extremity market and as well the market acceptance and penetration in our skin product lines, both in the US and abroad, also getting some benefit from the non-Europe international aspects of the overall business.

So pretty good. And if we can continue to drive the spine and orthobiologics in the right direction, we can continue to sustain orthopedic revenue growth well in excess of our competition.

Now, that said, the impact on gross margin is so complex and has so many pieces, I don't really think it changes our commentary about mix. There are a number of items that hit the quarter in terms of engineering expenses, plant activity in terms of restructuring, engineering activities on our new orthobiologic and regenerative medicine plants. And so while the number didn't show the mix improvement this quarter, we continue to expect the 75 to 100 basis point improvements going forward.

But one other point, if you look across the business. When we gave our guidance, we did not expect Instruments to be as strong as they were, and that certainly had a significant impact in the quarter being up more than 7%.

Okay.

And if you didn't catch it in Gerry's commentary, pricing didn't hit us really in any of our businesses and our spine is so small that it really doesn't impact the overall pricing mix for the Company.

Okay. And then my follow-up for clarification question is, just relative to Gerry's comments on CapEx, was that $10 million to $12 million per quarter going forward?

Yes. There was a little bit of a hiccup in Gerry's commentary, so let me just repeat it. And by the way, our ops guys who are listening are probably counting on the 20 he said. It's $10 million to $12 million a quarter. So it's an uptick from last year, but in line with the roughly $40 million that Jack's been talking about for a while.

All right, great. Thanks a lot.

Our next question will come from Amit Bhalla with Citi.

Hi, good morning.

Good morning.

I have a couple of questions on the Neuro side. The Neuro growth rate was a little bit lighter than we were expecting. I know in your prepared comments you made some comments about Europe. I was wondering if you could go into a little bit more detail about what's happening in Neuro. And when you look for the full year, are you still comfortable with the 6% to 8% target for the year, because it implies about 8% growth in the fourth quarter and you do have a tougher comp coming up?

Okay. First of all, Neuro US was good. Europe Neuro was bad. And the rest of the world was really, for the most part, quite good. If you recall the progression throughout the year, our initial guidance for Neuro for the full year -- and remember, we did that in, I guess, February -- was 5% to 7% for the full year.

Based on the first half of the year outperformance, we raised the guidance to 6% to 8% for the overall Neuro business. So this quarter, when added to the first two quarters, still keeps us in that range of 6% to 8% for Neuro. That being said, based on the third quarter number, we're probably at around the lower end of the overall 6% to 8% for the full year unless Neuro outperforms our results.

It's worth pointing out that Q4 of last year was the first quarter where we saw a significant improvement in our business after a really tough four quarters. So the Q4 2010 comparable is a lot more challenging than, for example, Q1 through Q3, hence our 5% revenue growth guidance for the fourth quarter.

Within that growth, you can look at Q4 with roughly the following parameters -- we expect Orthopedics to grow about 8% year-over-year; Neuro to grow about 5% year-over-year; and Instruments to be roughly flat year-over-year. And again, I'm just talking for the fourth quarter because I know it's a complicated model at the moment.

Okay, so just a quick follow-up on that gross margin, when you did take gross margin down in terms of guidance for the full year. So can you give us some commentary on 2011, anything qualitative you can tell us about the gross margin expectations going forward?

Yes. We're expecting gross margin in 2011 to increase over the average number for the full year 2010 by about 75 to 100 basis points. So our new expectation for full year 2010 is about a 63.5% for the year, so that's averaging the four quarters. And then next year we expect it to be up about 75 to 100 basis points. And again, that's mixed, but it's also some of the restructuring activity that we've been doing this year.

So that's probably enough for that question. Why don't I take the next question?

Thanks.

The next question will come from Bruce Jackson with Morgan Joseph.

Hey, Bruce.

Hey. Could you update us on your expansion plans in Asia-Pacific? On a past call, you said you were looking at distributors in certain areas, so what's going on with that?

Sure. Gerry will pick that one up.

Hello, Bruce. Over the past year we've been investing quite heavily into the Asia-Pacific region in terms of infrastructure. And as you know, over the past four or five years we've put significant investments building an infrastructure in our European markets to support local sales activities in those markets, and now we're shifting focus and expanding our Asian markets because we believe there is opportunity there that we have not tapped into up until this point.

As we look at those markets, we're trying to identify the largest markets we can have an impact in in the short-term and then build a strong presence to support continued growth over the long-term as well. Specifically, China, Korea, Japan are certainly the markets that we're focused in.

Over the last year, we went direct in our Australia and New Zealand. We just finished converting our Orthopedics business inside of Australia and New Zealand into a direct business, from a distributor network to direct, and we're continuing to work through adding to infrastructure.

As we look at having a presence in those markets, we're hiring people in-country that understand the local customs and cultures as well as can seek out the product opportunities and provide direct management oversight of the distributors in each of those markets. And we're exploring the possibility of opening up an office in Singapore where we can house several Integra employees to have more access to the distributor markets, more access to the customers to continue to increase that level of focus from a sales standpoint.

And then one question on spine. You've been giving us updates on what percentage of the hardware distributors are carrying the orthobiologic products, so I apologize if I missed that, if you gave it earlier. But what percentage of the hardware distributors are now carrying the orthobiologics? And that's it for me.

Okay. Of the spine dealers who sell about 75% of our spine hardware, they also carry our orthobiologics products. So we have the highest dollar generating distributors for hardware are carrying our orthobiologic products, and we're starting to get those orthobiologic products into the operating room, into the procedures where they're participating now.

So we feel pretty good about where we stand today, and we'll continue to work on increasing the number of distributors in our spine business who carry our orthobiologics and we expect that to get closer to above 90% over the next several months.

Bruce, I'll add just a couple of points. We continue to look for acquisitions in the developing markets, including buying our distributors. We bought our Australian distributor a couple of years ago. They've grown the business quite substantially, and we're in the process of bringing other product lines now to Australia through that dealer; that's a good example.

And we've got an active business development program to both acquire our dealers as well as to acquire other companies that can give us access more quickly than a Greenfield approach to some of the developing markets.

All right, great. Thanks.

We'll go next to Patrick Clingan with Lazard Capital Markets.

Good morning, guys.

Hey, Patrick.

Thanks for taking the question. And Gerry, congrats on the impending announcement and good luck on whittling down that handicap.

Thanks.

I guess I wanted to start a little bit on the revenue guidance for fourth quarter. It seems like you guys are expecting a deceleration, particularly in the extremities private label and then in the Instruments business. Just kind of wanted to get a feel for what you're seeing that suggested that those numbers will be kind of coming off of the growth rates we've seen over the last couple of quarters.

I would challenge the description of deceleration. We're expecting to grow sequentially and we're expecting our various businesses to grow sequentially. I think what you saw in the first half of the year was a favorable comparison because of the air pocket that happened in the first half of 2009 to so many companies, including ourselves.

So I think what you're seeing is a consistent trend in our businesses of improvement throughout the year. But as I mentioned earlier, Q4 last year was really the first quarter of improvement after a really tough year. So if you look at our fourth quarter objectives that we stated, it's in line -- or roughly in line -- with the original guidance that we began the year with.

And so I guess I would say we're not expecting any change in trends in the fourth quarter; it's just that we have a much tougher comparison versus prior year.

I guess maybe focusing in a little more on the Orthopedic business, you guys have shown sort of an accelerating growth rate for that division throughout the year. And it seems like your easiest comp is actually in the fourth quarter, so I guess I'm just wondering why that would grow at an 8% rate relative to the growth rates we've seen over the prior three quarters on tougher comps.

It's a hard one to answer except to say we're looking at the sequential performance of each of the different businesses and that's what it adds up to.

Okay, great. And then just wanted to follow-up on strength in the private label business given that it seems like INFUSE sales have been relative weak for Medtronic, but there's been a couple of quarters in a row where you guys have called out that's been rather strong. I just wanted to see what's driving that and maybe comment on the sustainability into the fourth quarter and for 2011. Thanks.

Okay. If you recall, we started the year with an expectation for private label of being essentially flat year-over-year. And indeed, it's one of the more pleasant surprises for the year is that year-over-year the performance was much better than anticipated.

So the components of that are one -- and recall, we don't comment on the individual product lines. And in particular, since everybody's so interested in INFUSE, you should talk to Medtronic about INFUSE, not us.

What I would say is a number of our product lines in private label get at the improvement in hospital infection rates, and so there's a number of the products that we sell that have really taken off in the last couple of years tied to some of the legislation around reducing hospital-based infections. And I think the performance of that particular part of the business was driving a lot of the surprise this year.

But again, it was across all of our product lines. And I suspect to some extent it had to do with the fact, again, that in 2009 a number of our OEM or private label customers did everything they could to bring down inventories. And now with the economy, or at least the US economy, improving a bit, they're actually seeing growth this year and therefore need to continue to grow their both inventories and their revenues.

So it's really not one thing; it's really across-the-board. That's about as much as I can say.

It sounds like the hospital infection reduction trend is something that is sustainable and could keep driving some growth, but that the inventory stocking maybe which gave outside returns this year maybe is not. Is that the right way to think about it?

That's too strong. Absolutely, the infection control trend will continue into 2011. I don't think that this year was a stocking phenomenon. I think we started the year conservative because we really had no sense for what our partners' performance would be, and it turned out it was a lot better than expected.

Now, Angela has now whispered in my ear and corrected me that we don't expect private label in Q4 to grow over Q3, so that's part of what's going on in Q4.

Okay, great. Thanks so much.

We'll hear next from Raymond James' Jayson Bedford.

Hi. Good morning, guys, and nice quarter. I guess just looking at the growth in the Instrument business, up 7%, clearly a sharp acceleration from what you've been seeing. I'm just wondering if you can give us a little more detail on the strength and then maybe also comment on inventory levels, large order, etc.?

The good news about the third quarter in Instruments for sure is it's not one or two large orders. It really was -- a -- let me go in reverse order of Gerry's overview -- one, the physician office space part of the business grew basically in line with our partners' out-the-door sales. So out-the-door sales grew and our shipments in grew and they're not growing their inventories to the best of our knowledge, but it's just a gradual improvement going on in the environment, again, compared to a tough 2009.

If you recall in our hospital-based part of the business, our story for five years was that we're taking share from the competition, and that was hard to convince anybody of given the poor performance of the business in the last year or two. But then again, if you look at our peers, they were all performing poorly, too.

We're taking share in Instruments. Our hospital-based business in Instruments is really a strong performer, we're very customer-centric, we've got the best ability to deliver next-day, a broad range of SKUs, and a really incredible supply chain.

And, by the way, with all the acquisitions that we've done over the last several years in that category, probably the broadest range of specialty instruments, which, by the way, have pretty good gross margins. So I think that played out in the third quarter.

Also, our lighting systems, which have been a little bit of a thorn in the side over the last few years, performed well in the quarter and it's because I think a lot of the kinks in the acquisition have come out and it is benefiting to some extent from the improvement in hospital capital abilities like some of the things going on in Neuro. So net-net, a shout out to our Instrument group because it was just a solid performance.

Okay. Fair. And just my follow-up. Looking at your comments for 2011 -- and I realize that 2010 is coming in above your expectation, or your initial expectation. I think you talked about 6% top-line growth in 2011, and I think historically you had talked about 7% to 9%. So I'm just wondering, what has changed beyond just a strong 2010 in your thought process there?

[It all came to] nothing's changed about our thought process for 2011. We're looking around at what our sales people are rolling up for 2011 and what our comparable peer companies are saying about their expectations for 2011. What's for sure in the last few years is that nobody has a crystal ball and we see really no benefit to setting guidance for 2011 either in excess of the street or in excess of what similar companies are saying.

So there's no new factor that factors into 2011. I think our main goal in that commentary is to make sure that based on what was a really spectacular quarter, people don't raise their numbers for 2011.

Okay, thank you.

(Operator Instructions). We'll go next to Glenn Novarro with RBC Capital Markets.

Stu, I have a question on the extremities market. We're seeing the knee and hip markets slow here in the third quarter. I wonder if you can provide some color on the extremities market. Obviously, knees and hips are slowing because of the economy and unemployment. Have you seen any step-down in extremity market growth here in the third quarter? And then, any commentary is Integra growing with the market or growing above the market? Thank you.

Thank you. Yes, this is Gerry, Glenn. On the extremity market, if I look at over the quarter in comparison to what the market growth rates are, we are growing way above the market growth rate in terms of numbers of procedures that are being done, which means we're taking share as well as keeping up with market growth.

We had a really solid quarter in extremity reconstruction. We're not seeing any step-down in procedure volume. We do see not as much growth in the forefoot side, which is mostly the podiatric surgery treating bunionectomies and some of those procedures.

But we're seeing increases in sales across our mid and hindfoot, which are usually the more complex procedures where surgeons are doing reconstruction of -- dealing with a diabetic patient and dealing with arthritic patients that need reconstruction of the joint of the foot and ankle. And our hand business has been up pretty well as well.

So I think overall across the product lines we've seen acceleration and growth across our midfoot, hindfoot and our wrist fusion products and we don't see a step down like you're seeing in the hip and knee business. Now remember, this is a newer focus for a lot of companies. It's new procedures that are being introduced to surgeons who didn't have very good solutions in the past.

And by focusing on the disease state selling that we've been able to develop a strategy around, we've been able to really keep our people focused on those patients and those procedures and provide educational opportunities to surgeons who otherwise may have not treated those patients in the past the same way. And we're just giving them better solutions to be able to treat those patients to get better outcomes in the future.

(inaudible).

I'd add to that --. Sorry, Glenn. I'd add to that that we continue to see extremities both in the US and outside of our domestic market as a real growth area and have some significant expectations to invest in that in sales force growth next year. So I think that's going to continue to be an important part of our story as it has been for the last four years. Sorry, Glenn --.

Yes, two follow-ups. We think in the US, [through our research] tells that the extremities market -- hand, wrist, foot, ankle -- is growing 8% to 10%. Is that still a good number? And then any commentary on pricing? I would imagine pricing in extremities for you guys is probably flat to still up. Is that correct?

Yes, I'd say -- I'll take the second part of it, the pricing side. We're not seeing pressure in that market; we're actually seeing price increases stick in that market. And as we introduce new products that are premium priced that are procedural specific, we're having success in terms of launching those products and we're not seeing pressure on that.

As far as the market growth rate, it's hard for us to say. I can only go by what -- the same reports that you're reading in the marketplace, and we don't have any better market intelligence than that right now.

Okay, thank you.

We'll go next to Mike Weinstein with JP Morgan.

Hi, Mike.

Hi, there. It's actually Kim in for Mike.

Hi, Kim. How are you?

I'm great. How are you doing?

Fine, thank you.

Good, good. So a couple of questions. The first is on gross margin, and just wondering if you could kind of break out for us what was the net mix impact in the quarter from gross margin? And then as we move forward, how do we think about the timing of when the restructuring activity starts to really benefit at gross margin line? And then I've got a follow-up.

Good questions, but I really don't have -- and we don't I don't think plan to provide detail on the components of the gross margin. So mix certainly helped, and some of the activity in the quarter in terms of write-off and expenses around the restructuring hurt, but that's as much detail, Kim, as I can provide.

And in terms of the expected impact, we talked first of all about a couple of site closures that are going on now and integration that's [tuned into] some of the gross margin performance for the quarter. Remember, we report our gross margins on a GAAP basis, so you can go to the back of the press release to look at the specific impact of restructuring expense and how it hit the GAAP gross margin.

And in terms of the impact of next year, it's a combination of mix and the improvement in our expense structure that we believe will drive the 75 to 100 point gross margin increase next year.

Given our commentary around next year being about 6% over this year, mix is a little less important. Keep that in mind as you think about our guidance.

Okay, great. And the follow-up is actually just on the extremities side. You guys have done a great job building out that business. And just curious as you look at your sales bag, maybe what one or two product areas within extremity are you not servicing today that you might be kind of interested in adding to the bag?

This is Gerry. I think that we look at the product portfolio that we have. We have a fairly comprehensive product portfolio, and I think our objective as we go forward and as we have in the past we look across each section of the portfolio, whether it be upper extremity, lower extremity, or our skin business in orthobiologics, and look at where we can continue to add products that will add a clinical advantage or allow a surgeon to complete a procedure without products that they can't currently complete.

There's not a -- and we won't talk about any specific products that we'll launch in the future because we try not to pre-disclose that just for competitive reasons. I think if we look out across the portfolio I think it's safe to assume we'll continue to invest significantly in product development to have a robust product line and introduce products across both mid and hindfoot as well as hand and wrist in our orthobiologics and skin businesses in order to balance out the portfolio and continue the growth in that area.

Okay, great. Thanks, guys.

We'll go next to Matt Miksic with Piper Jaffray.

Hi, Matt.

Hi. Sorry about earlier; had you on mute. So thanks for looping me back in here. First, Gerry, thanks for all of your help over the years and, of course, your insight on Integra's markets, as you would say. (laughter). I wish you the very best [with your life].

There's a lot of questions been asked here, but I had one follow-up on -- and I apologize, we're all juggling a lot of calls and I don't know how much you've drilled into this. But one follow-up on just how the spine opportunity is playing out for you and how it's different than the other players, the other results that we're seeing in the marketplace. And then I had one follow-up.

In other words, how is price affecting you? How are new accounts opening? How are some of the new products impacting your ability to get to those accounts? And again, I'll apologize if this is something that you've gone over.

No, it's worth reiterating. First, keep in mind we're relatively new entrants to the spine market. So a combination of our original launch of Mosaic, the acquisition of IsoTis and the acquisition of Theken a few years ago, so you're talking about over a three to four-year period building an over $100 million franchise.

If you do the math -- because I was thinking about it this morning -- at an acquisition multiple in line in certain respects on average with what we've paid for Instrument businesses. So a really good use of shareholder capital to build an extraordinary franchise that already puts us in sight of being in the top 10 players.

That's not without its challenges. But I want to be absolutely clear, we're 100% committed to the business and, indeed, expect to, when we're done with this series of integration activities and doing all the things that our team is doing, we absolutely expect to be moving not just into the top 10 but into the top tier player group.

And by the way, I think our track record speaks for it, having moved to be the number one in Neurosurgery, coming on to number one in Surgical Instruments, and taking a little bit longer time period in the top five players in the extremity market. So I would hope investors would have confidence in our ability to put together a strategy and execute on it.

Now, part of the last couple of years have required us to maintain the spine business relatively independently of Integra and relatively independently of our orthobiologics and other activities. And so now with the earn-out period done, there's really quite a nice opportunity to get some leverage.

And I think people start to see that in the NASS meeting where we presented it as an important component of Integra as a Company and we saw neurosurgeons at CNS really start to appreciate what our significant presence in spine is. And furthermore, our strategy of having a very broad-based product line including MIS and orthobiologics puts us already on par with many of the mid-size players.

So, where does that lead? We've got a lot of the same phenomenon that other mid-size players have. Some of them performed particularly well this quarter, some poorly; that put us in the average category. Pricing is no worse for us than anyone else. I'm going to get out of the habit of reporting on ASPs by quarter, but the first half of the year everybody's been talking about pricing being down. We didn't see it get any worse in the third quarter, but our insights are probably, although probably welcome, somewhat limited in their general applicability.

So we're 100% committed to spine. We intend to be a major player there. We'll leverage our Neurosurgery relationships, our orthobiologics and soft tissue capabilities, and I think be a winner in spine.

And then one follow-up on biologics. An important driver within orthopedics, obviously, but any areas that you're seeing that are -- where the competitive landscape is changing in sort of any of the applications where you're sort of -- your bovine collagen is used, whether it's sort of on the trauma, skin, tissue side, whether it's on reconstructive --.

The competitive landscape there getting tougher? Are you finding that you have a greater advantage than you did a few years ago because of your metal business? Any color there would be helpful.

Start with spine. It's not so bad to have two of your major competitors bought in the six-month period. So on the orthobiologic side, I think that poses some competitive up-side for us.

In the extremities business, I think what you're seeing is a -- and it's taken 20 years for this to happen -- but a general acceptance that advanced technologies for repairing wounds, in particular, are an important part of not just a specialist group of surgeons that care about tissue regeneration, but the rank and file surgical podiatry, reconstructive surgeon, wound care clinic adopting new technology.

One of the critical drivers of that business is the growth in our Integra skin products. And then, if you look at national trends toward diabetes and obesity, they all point to significant damage -- and by the way, neuropathy in feet, which means that our skin and our nerve and our tendon and our hind and midfoot products are all hitting a really important medical need that is very topical today.

So going back a few years, maybe, how much of your surgical procedures, implants, instruments exposure in the podiatric surgeon segment were pulling through biologics in terms of Integra Skin, for example? And how has that changed in terms of maybe penetration of those procedures or a percentage of pull through or however you look at it?

I don't even know how to answer that except to say it's very positive. And maybe I should say our extremity reps, both in the US and abroad, carry both the metal and the skin. So when they're seeing an orthopod or surgical podiatry, they're showing them all of the products and are able to detail all of the products, and so we get the whole benefit of all roughly 125 US reps and about half that outside the US selling all of these products. So maybe that's an answer to the question. Gerry [might add something].

Yes. I think, Matt, if you look at our business, go back to 2005 when we entered into sort of the hardware or implant side of that business and then started combining our skin products with that sales organization, we started out with about 10 to 12 sales people in 2005. And now we've been able to grow to one of the largest direct selling organizations, and get above average, a strong double-digit growth rate since we entered that market.

How has skin helped us or how has that changed? It's having the combination of the hardware products and the skin products, and then being able to fund and finance the growth of our selling organization to bring this product technology to a group of surgeons that we really didn't call on in the past.

So we've really expanded our customer base across all the extremity reconstruction markets and specifically into this target audience to provide the skin products and other technologies that have really improved their practice.

Maybe another statistic that will help is of the extremity business, which we don't break out specifically, but we've generally said worldwide plus or minus $120 million, about half is soft tissue and orthobiologics, about half is metal. Don't take that $120 million and use it in today's numbers because we just give round numbers there, so it's about half metal and about half soft tissue and orthobiologics. So that's another way to think about (inaudible - multiple speakers).

Yes, so the question to that point about penetration, and that doesn't necessarily mean that half your procedures are using biologics, I understand that. But, Gerry, when you talk about where you were when you got the metal side of that business, you're detailing these products to surgeons.

I guess in terms of general practice, Stu, you talked about the use of these advanced technologies. Has that gone from 10%, 15%, 20% of the cases using advanced technology in the repair of the wound of those procedures to something higher, or is it just your penetration of an existing market? I guess that's what I'm trying to get at.

Why don't we take the question off-line; we'll see if we can do a better job answering it for you.

Fair enough. Thanks.

Our next question will come from David Toung with Argus Research.

Good morning. Thank you for taking my call. Stuart, one of the hospital companies reported yesterday a 5.5% increase in surgical volume, the same hospital. I know they may not necessarily overlap with you guys, but is that something that you can factor in? Are you seeing anything similar or is it different? It certainly seems to be a disconnect with what the orthopedic people are saying.

Gut reaction, because I didn't see the report, I don't think hospitals are in general seeing 5% increases in procedure volume, so they must just be managing really well. I think we're seeing --.

A lot of it's outpatient, too.

I don't even want to speculate on surgical volumes, David, really. I think you ought to talk to the broader group of hospital companies on it. We're not the source of data on that.

Okay. I think a lot of it is also they include the outpatient statistics in there, too. But that's fine. Thank you.

On the topic of outpatient, remember, in our Instrument business we kind of get the benefit of whichever grows faster because we cover both surgery centers, physician office practices and hospitals, and we're really the only instrument Company with that breadth of coverage, so that may help a little bit.

Our next question will come from David Lewis with Morgan Stanley.

Hey, David.

Hi. Good morning. It's [Steve Bashaw] here for David. Thanks for taking the question.

Hi, Steve.

I want to dig a little deeper on a couple of topics that you've touched on briefly. First of all, as you think about your acquisition strategy going forward, could you comment specifically on what you're seeing in terms of asset pricing sequentially? In the past, it seems like you implied that asset prices were not at a level that you felt they were reasonable. Is that changing?

Yes, I think people are getting tired. So yes, I think so. At the depth of the economic crisis, you had the following things going on. You had companies like ourselves change our focus from doing acquisitions to paying down debt and being as liquid as possible, and I think we did a really good job paying off more than $200 million of debt in a reasonably short period of time and postponing acquisitions.

Then I think what you had is, particularly in markets where we're playing is we like to buy companies that are profitable, that are relatively maybe distribution challenged but are well run and generally throw a positive cash flow. So if you're that private company, you always have the choice not to sell. And I think that was what really went on in the last two years -- a combination of us not wanting to buy and private company sellers not wanting to sell.

And so we went from generally looking to pay five to eight times cash flow for our acquisitions, or five to eight times operating profit, rough numbers, for acquisitions, taking the point of view while really given the economy and given our own stock price, we really could only pay four to five times, and those guys didn't really change their views.

I think what's happened a bit is time goes by. If a private company wants to sell, eventually they've got to get real about the price expectations and so I think those have come down. And I also think that given the improvement in the financial markets, our access to capital being as good as it is now, we're not down at that only willing to pay four to five times level, but we're more thinking back to historical multiples, five to eight. And so I think there's more of an overlap.

And then you might say, "Well, geez, but you haven't done an acquisition this year." Well, we've actually looked at a lot, but we've walked away from a few. And I think we've always said we won't set targets for acquisitions; we don't build them into our guidance because we don't want to be in a position where we would be doing a dumb deal just to meet some external expectations.

And so we continue to be very enthusiastic about our ability to acquire, add businesses. We're looking at all of our categories -- spine, neuro, instruments, extremities -- and hope to be back on the track of doing three to four deals a year. Whether one would get done this year or not I think is open to question, particularly given the lateness of the year, but you never know.

And so yes -- long answer to your question -- I think demand for price has come down and willingness, certainly, on our part to pay a little more than we would in the depth of the financial crisis has gone up, and I think we're back to levels prior to the financial crisis two or three years ago.

Thanks. That's very helpful color. I want to dig a little deeper on one other topic, and that is the dynamic that hospitals are facing and the underlying drivers of their interest in talking to Integra in cases where Integra might not have been an existing customer. How are you seeing the motivations of hospitals evolve? They increasingly are looking at Integra as a supplier? And what's the balance there between their interest, because Integra has an expanding and improving product line in orthopedics and spine as opposed to hospitals thinking more about diversification of suppliers or potentially pricing?

Okay. I think that plays to our advantage, where the market is going. Data is getting better for hospitals. There's more transparency and they want to consolidate their vendors to vendors who can provide a good bundle of products, high quality and cost effective products. And so being bigger is better, and competing with bigger companies implies we need the ability to talk across all our product lines and provide a value across our product lines.

If you go back five or six years ago when we started the strategy of diversification for the Company and got into the instrument business, why did we get into the instrument business? We said -- one, the Company had no GPO relationships or understanding; we did not have a contracting capability; and we had mostly reasonably expensive neurosurgery products that were under price attack and we needed to respond.

And so by having a range of surgical instruments that are critical for hospitals, that are a focus area for purchasing in hospitals, and being able to deliver a good value would allow us to present a broad contract to customers, that they could say we're a valued supplier.

And that's happening now in spades, and we'll continue to invest in our GPO relationships, which I think are at the highest point they've ever been. We'll continue to invest in IDN and individual hospital contracting and we'll continue to try to get all of the divisions of Integra in front of the hospital to show them -- a, the breadth of our product line; and b, how we can help them save money.

And by the way, it would help if they actually knew they were buying products from us, hence the new branding. We have still places that buy our Neuro products and don't even know they're buying our Instrument products and, of course, that's all our obligation to inform them. And so our one Integra branding that we're doing with Limit Uncertainty is all about trying to communicate to the hospitals that we're a critical vendor providing cost effective products that help hospitals limit uncertainty around a whole range of things.

One other point, and I'll just point to an anecdote, and anecdotes don't make a business, but I'll make a point. There was recently an interesting hospital system tender where they said to vendors, "We're going from 30 vendors down to three for spine." And everybody had to put their best foot forward, and I won't go into details, but put their best foot forward, and it was not just about price.

And they said, "We're going to knock 27 out of 30 vendors out." The way it actually played out is they ended up with eight vendors, of which we were one. And it wasn't because we had big spine market share, but we were able to persuade them that we were a critical neuro vendor and the combination of our neuro, spine, and orthobiologics businesses should argue for them to have us increase market share at other people's expense.

And so we would -- we've got a 1% share of the metal spine market. We've got about a 10% share of the US orthobiologics market. Man, that's a lot of opportunity for Integra, simply from consolidation of vendors. And we may not take our share from the top one or two players, but there's a lot of little spine companies who we can take share from, that we've got a broader product line and as good or better service.

Thank you again. That's very helpful.

We have a follow-up from Bill Plovanic with Canaccord.

Hey, Bill.

I'll keep this short. Just when do you expect the biologics OUS with the re-registration to have troughed? Is that a Q3 trough? Is it a Q4 trough, and then work up from there?

It's actually a Q3 trough, so we'll see some improvement in Q4; we know we will.

All right, great. Thanks. That's it.

And we have no further questions at this time. I would like to turn the call back to Mr. Stuart Essig for closing remarks.

Well, thank you all for joining us for this call. And just without belaboring the call, I really want to wish Gerry Carlozzi well. He's been a great partner for me and for Integra for the last seven years. It's been a true pleasure to work with him, and I look forward to working with Pete Arduini to have a similar great future.

Take care.

That does conclude today's presentation. We thank you for your participation.